Half Yearly Report

6 September 2012

SQS Software Quality Systems AG

("SQS" or the "Company")

Results for the six months ended 30 June 2012

SQS Software Quality Systems AG (AIM: SQS.L), the world's leading specialist in software quality services, today announces its unaudited results for the six months ended 30 June 2012 (the "period").

Financial Highlights:

·; Turnover increased by 7.9% to €102.8m (H1 2011: €95.3m)

·; Gross profit up 10.4% to €31.5m (H1 2011: €28.6m)

·; Adjusted* PBT increased by 18.6% to €3.3m (H1 2011: €2.8m)

·; Adjusted** EPS €0.09 (H1 2011: €0.09) - due to return to more normal tax rate of 24% (H1 2011: 13%)

·; Operating cash flow improved to €3.1m (H1 2011: cash outflow of €1.3m)

·; Net debt as of 30 June reduced 15% to €14.3m (H1 2011: €16.8m)

*adjusted to add back €0.8m of amortisation of intangible assets of acquired companies and €0.03m pro forma interest on deferred payment milestones for acquisitions.

** adjustments under * and an add back of €0.3m for deferred tax income.

Operational Highlights:

·; Revenues from Managed Services contracts almost double the same period last year at €34m (H1 2011: €17.9m), now accounting for 33% of total revenue (H1 2011: 19%)

·; Gross margin from Managed Services contracts improved by 5.5% to 29.9% (H1 2011: 24.4%)

·; Adjusted* EBIT margin improved to 4.1% (H1 2011: 3.6%) despite additional costs of €1.1m incurred in recruiting consultants, redundancy costs on certain overheads and start-up costs of the US business

·; Number of permanent consultants increased by 9% to 1,826 (31 Dec 2011: 1,675)

·; Transfer of responsibility to new CEO completed and well receivedby clients and internal organisation

Diederik Vos, the designated Chief Executive Officer of SQS, commented, "We have continued to outperform the software testing market during the period giving further evidence of the success of our strategy to focus on Managed Services. This strategy, which is to grow Managed Services to at least 40% of total revenues, is delivering increased visibility and improved margins and these benefits will continue to improve as existing contracts further mature.

"Our initiative to focus on value based pricing for higher value services is expected to lead to improved gross margins and this, together with the recent successful completion of our investment activities, gives us confidence in further improved cash flow and reduced net debt going forward.

"Although continued economic uncertainties require us to remain cautious, in line with previous years, we expect operating margins to improve during the second half and we are therefore confident of meeting full year market expectations."

 Enquiries:

About SQS

SQS is the world's leading specialist in software quality. This position stems from 30 years of successful consultancy operation. SQS consultants provide solutions for all aspects of quality throughout the whole software product lifecycle driven by a standardised methodology and deep experience in various industries. Headquartered in Cologne, Germany, the company employs approximately 2,200 staff. Along with a strong presence in Germany and the UK, SQS has further subsidiaries in Egypt, Finland, France, India, Ireland, the Netherlands, Norway, Austria, Sweden, Switzerland, South Africa and the US. In addition, SQS maintains a minority stake in a company in Portugal. In 2011, SQS generated revenues of 189.1 million Euros.

SQS is the first German company to have a primary listing on the AIM (Alternative Investment Market) in London. In addition, SQS is also traded on the open market of the German Stock Exchange in Frankfurt am Main.

With over 7,000 completed projects under its belt, SQS has a strong client base, including half of the DAX 30, nearly a third of the STOXX 50 and 20 per cent of the FTSE 100 companies. These include, among others, Allianz, Beazley, BP, Centrica, Daimler, Deutsche Post, Generali, JP Morgan, Meteor, Reuters and Volkswagen as well as companies from many other industry sectors.

For more information, see www.sqs.com.

Designated Chief Executive's Statement

Introduction

The first six months of 2012 represented a period of continued growth, particularly in our Managed Services business where revenues were almost double that in the same period last year at €34 million (H1 2011: €17.9 million) and now represent 33% of total revenues (H1 2011: 19%). In addition, we successfully completed our investment programme into our test centres and investments in Practiq methodology and infrastructure have returned to a "maintenance" level such that there will be lower investment costs for the remainder of 2012.

During the period we successfully increased revenues and profits and improved margins across all of our core geographies. Revenues increased 7.9% to €102.8 million (H1 2011: €95.3 million) strongly outperforming the European testing market (H1 2012: -1%).

Adjusted EBIT* and adjusted PBT* increased 23.9% and 18.6% respectively despite a €0.3 million impact from adverse exchange rate movements due to the weakening Euro against Sterling and the Swiss Franc.

*adjusted to add back €0.8 million of amortisation of intangible assets of acquired companies and €0.03 million pro forma interest on deferred payment milestones for acquisitions.

Despite reported profit before tax increasing 29.6% to €2.5 million, taxes on income from operations under local GAAP resulted in an adjusted profit after tax increase of 4.1%. The tax rate on local GAAP results was 24% (H1 2011: 13%), which was a return to a more normal tax rate after tax breaks and other one-off effects produced an unusually low local GAAP tax rate in H1 last year.

Notwithstanding the above, cash conversion and operating cash flow improved from a negative €1.3 million for H1 2011 to a positive €3.1 million for H1 2012. During the period we were also able to reduce our financial debt by €2.4 million (compared with H1 2011) reversing the increase of €7.6 million in H1 2011 and bringing net debt down 15% to €14.3 million.

The period has also seen the introduction of a number of strategic initiatives, including value pricing which involves greater granularity of pricing for services, allowing us to charge more appropriate fees for our higher value offerings. In addition we are aiming to focus our attention on larger contracts, setting a minimum engagement size of €1.5 million, and on the 6 key industries in which our core competencies reside.

The six months under review have therefore been a successful period for the Company and the developments and progress made during this time leave us in a strong position from which to continue to outperform the testing market going forward.

New Business

Although we have continued to add new clients at a steady rate, with over 100 signed during the period, our focus has been on increasing the value attained from existing clients. Our success in this respect can be evidenced through the significant growth in revenues from Managed Services business during the period, with a number of our larger clients, including a major European car manufacturer, transitioning to such contracts resulting in improved margins.

In addition, a number of our larger contracts are delivering revenues substantially ahead of those which were initially contracted and our focus going forward will be to enter into larger engagements. Reflecting this, we have a set a minimum size target of €1.5m per year for any new engagements.

Further to this, our previously announced preferred partnership with industrial automation supplier Siemens to provide testing services to its industrial clients is resulting in numerous initial contracts and is acting as an excellent platform from which to expand into the US market and to extend our offering into the high margin software product testing and certification market.

Market & Industry Overview

The software testing landscape is changing and we expect the pace of change within our industry to continue for the foreseeable future as software quality and reliability becomes increasingly important in today's digitised marketplace.

A 2012 report published by Nelson Hall, a well-respected industry research agency, has forecasted that the total global market for testing services in 2012 is expected to be worth approximately $33.4bn. Within this global services market, 'Specialist Testing Services' is expected to increase approximately 2% to $8.6bn in 2012 and a significant 10% in 2013. For H1 2012 we again outperformed the market growth fourfold with a growth of 7.9%. The report highlights that software testing contracts are evolving into high-value multi-year contracts under managed service agreements with 'Specialist Testing Services' expanding into new market segments such as energy & utilities and manufacturing in addition to financial services continuing to represent the largest and fastest growing industry vertical.

This market study also revealed that 58% of all software testing services purchase decisions are made by clients seeking efficiency, a demand typically fulfilled by managed services contracts. This supports our managed services strategy.

The consolidation within the IT services industry has continued during 2012 with the acquisition of Logica by CGI Group Inc and whilst specific opportunities to consolidate the industry further exist, significant consolidation within the pure-play software testing services sector has stalled during the first half of 2012. Whilst SQS can foresee significant organic growth opportunities in Europe, the Company has decided to evaluate suitable acquisition opportunities both in Europe and overseas, mainly in the area of "Specialist Consultancy Services".

Strategy

The overall strategy of the Group remains on track to build SQS into the world's leading specialist in software quality services with revenue heading towards €300m by 2014 and targeting €500m by 2017, from both existing and new markets.

Our three primary service offerings are Managed Services (MS) to meet the demand of clients seeking efficiency, Specialist Consultancy Services (SCS) to meet the demand of clients seeking transformation and quality and Regular Testing Services (RTS) to meet the demand of more price conscious clients, who tend to be served on a more local basis. The long-term goal is to achieve a segment mix for MS, SCS and RTS of approximately 40%, 25% and 35% respectively (in H1 2012, the approximate mix was 33%, 15% and 52%), which should deliver further margin expansion through the introduction of value-based pricing, balancing onsite and test centre delivery and the continued alignment of overheads. Going forward the Company will report its revenues by these key business lines.

We also intend to focus more on appropriate pricing for our services, such that we derive greater revenues from our high value services. In addition, we will look to target new business within the six key industry verticals in which SQS has strong domain, application and technology expertise. Furthermore, we plan to extend our services into the software product testing and certification markets which enjoy higher margins and a greater level of repeat business.

Dividend

In accordance with German law, SQS can only pay one dividend in each financial year. We expect to declare a dividend with our final results for the year ending 31 December 2012, in line with our current policy of paying out a fixed proportion of full year earnings.

Board

Over the past six months Rudolf van Megen has been handing over activities to his successor as CEO Diederik Vos. Diederik is now based at the Company's headquarters in Cologne and the transition has been successfully effected. SQS would again like to thank Rudolf for his inestimable services to a business that he co-founded over thirty years ago and has since grown to over €200m in revenues.

Looking forward we intend to make two new additions to the Board comprising of a Chief Marketing and Sales Officer, in charge of overall marketing and sales, and a Chief Operating Officer in charge of group operations. These appointments will be integral to the successful implementation of our stated strategy to grow SQS to a €500m revenue company.

Employees

Employee headcount was managed carefully during the period to reflect market demand with a strong focus on utilisation rates. The period end number of permanent consultants increased 9% to 1,826 (31 Dec 2011: 1,675) with an optional 220 contractors retained during the period. Pricing pressures were also largely offset by our ability to reduce consultant costs (down 2.4% from H1 2011) in line with the wider macroeconomic environment.

Test centre headcount (offshore and nearshore) was maintained from December 2011 at 42% of the group's total headcount, because of the requirement from new Managed Services contracts to have a higher on-site presence during their initial phases.

Outlook

We have continued to outperform the software testing market during the period giving further evidence of the success of our strategy to focus on Managed Services. This strategy, which is to grow Managed Services to at least 40% of total revenues, is delivering increased visibility and improved margins and these benefits will continue to improve as contracts mature further.

Our initiative to focus on value based pricing for higher value services is expected to lead to improved gross margins and this, together with the recent successful completion of our investment activities, gives us confidence in further improved cash flow and reduced net debt going forward.

Although continued economic uncertainties require us to remain cautious, in line with previous years, we expect operating margins to improve during the second half and we are therefore confident of meeting full year market expectations.

Diederik VosChief Operating Officer, designated Chief Executive Officer6 September 2012

Financial Review

Summary

SQS Group turnover grew by 7.9% to €102.8 million (H1 2011: €95.3 million) during the period.

The business units, which also represent the accounting segments according to IFRS 8, are:

Central Europe Middle East (CEME), which includes the services and tools businesses in the markets of Germany, Switzerland, Austria, Netherlands, France and Egypt. Furthermore, this segment manages all billable staff that are employed by the aforementioned countries including the German / French-language offshore centre in Egypt.

West Organisation North South (WONS), which includes the services and tools businesses in the markets of the United Kingdom, Ireland, Sweden, Norway, Finland, USA, South Africa and India. Furthermore, this segment manages all billable staff that are employed by the aforementioned countries including the English-language offshore centres in India and South Africa.

Other, which includes training & conferences and central group activities such as research and innovation.

Breakdown by business unit

Central Europe Middle East (CEME)

Revenue in CEME, our largest market, amounted to €63.9 million in the period (H1 2011: €56.5 million), an increase of 13.2%. The improvement in revenue was entirely organic and predominantly came from new managed services contracts.

West Organisation North South (WONS)

Our business in this segment is predominantly English speaking and saw modest growth during the period with a 3.0% rise in revenues to €36.8 million (H1 2011: €35.7 million). This occurred primarily as the result of healthy demand for our services from the UK, Ireland and the USA. The majority of the growth came from the retail sectors and new managed services contracts in those industries.

Other Business

This segment experienced a decline in revenues during the period of 32.0% to €2.1 million (H1 2011: €3.1 million). While the revenue from training and conferences was approximately flat on the same period of the prior year, our direct revenues from software testing products were re-allocated to the CEME and WONS units due to a corresponding change of the internal organisation since January 2012.

Margins and Profitability

Gross profit improved by 10.4% to €31.5 million (H1 2011: €28.6 million), with the gross margin at 30.7% (H1 2011: 30.0%). The increase in the gross margin was mainly influenced by an improved gross margin from managed services contracts with a gross margin of 29.9% (H1 2011: 24.4%) with more contracts now entering a more mature life cycle phase. Gross margins from our traditional consulting business operated through our own consultants was 33.0% (H1 2011: 33.5%) reflecting some price pressure despite high utilization levels.

Adjusted* profit before tax for the period was €3.3 million (H1 2011: €2.8 million), an increase of 18.6%, with the adjusted profit margin rising to 3.2% (H1 2011: 3.0%). The profit before taxes was impacted by an exceptionally high amount of €0.3 million for exchange rate losses from intercompany transactions due to the Euro weakness against other currencies.

Adjusted** earnings per share remained at €0.09 (H1 2011: €0.09).

*adjusted to add back €0.8 million of amortisation of intangible assets of acquired companies, €0.03 million pro forma interest on deferred payment milestones for acquisitions and €0.3 million for deferred tax income. 

**includes adjustments under * and an add back of €0.3m for deferred tax income.

Costs

General & Administrative expenses (before IFRS amortisation of intangible assets of acquired companies of €0.8 million) for the period were €17.8 million (H1 2011: €16.0 million). This growth was mainly due to increased hiring and training costs (€0.5 million), further investment in the US business (€0.3 million) and redundancy payments (€0.3 million).

Sales & Marketing costs for the period were €7.9 million (H1 2011: €7.4 million), decreasing to 7.7% as a proportion of sales (H1 2011: 7.8%). This proportionately lower expense was the result of higher efficiency within the existing sales team and the increased focus on higher value clients.

Research & Development expense during the period reduced slightly to €1.6 million (H1 2011: €1.7 million) representing 1.6% (H1 2011: 1.8%) of revenues. Research and development investment was mainly focused on the development of software testing tools and our unique PractiQ methodology.

Cash Flow and Financing

Cash flow from operating activities increased strongly to €3.1 million (H1 2011: €1.3 million outflow). The primary reason for the return to positivecash flow was the improved invoicing workflow, particularly with our largest clients, despite an increase in total debtor days (incl. work in progress) to 73.5 (H1 2011: 72).

Cash outflow from investments decreased significantly to €1.9 million (H1 2011 €3.8million outflow) due to a return to more "normal" investment levels post last year's investment in a building for our India based offshore test centre.

Cash outflow from financing activities was €2.2 million (H1 2010: €8.5 million inflow) reflecting theredemption of a €3.0m bonded loan in March 2012.

Balance Sheet

We closed the period with €6.7 million (30 June 2011: €6.7 million) of cash on the balance sheet and borrowings of €21.0 million (30 June 2011: €20.5 million plus €3.0 million bonded loan). The resulting net debt position at the period end was therefore €14.3 million (30 June 2011: €13.8 million plus €3.0 million bonded loan). These movements are in line with our policy to reduce net debt by freeing up positive cash flow from operations and lower investment levels.

Taxation

The tax charge of €0.5 million (H1 2011: €0.5 million) includes current tax expenses of €0.8 million (H1 2011: €0.4 million) and deferred tax income of €0.3 million (H1 2011: tax expense €0.1 million). The tax rate on local GAAP results was 24% (H1 2011: 13%), which was a return to more normal tax rates after tax breaks and other one-off effects produced an unusually low local GAAP tax rate last year. For the full year, we expect an actual tax rate of 29%.

Foreign Exchange

Approximately 51% of the Group's turnover is now generated in Euros. For the conversion of revenues and costs generated in local currencies into Euros, the relevant official average exchange rate for the six-month-period of 2012 was chosen. For the conversion of the balance sheet items from local currency into Euros, the official exchange rate as at 30 June 2012 was used.

Foreign exchange had a minimal €51,000 positive translational impact on earnings for the period. Had the Pound/Swiss, Franc/Indian, Rupee/Swedish and Krona/Euro exchange rates remained the same as in H1 2011, our non-Euro revenues for the period would have been €1.8 million lower, resulting in a reduction in PBT of €51,000.

International Financial Reporting Standards (IFRS)

The Interim Consolidated Financial Statements of SQS and its subsidiary companies ("SQS Group") are prepared in conformity with all IFRS (International Financial Reporting Standards, formerly International Accounting Standards) and Interpretations of the IASB (International Accounting Standards Board) which are mandatory at 30 June 2012, whereas the interim reports are published in an abbreviated form according to IAS 34. The Interim Consolidated Financial Statements have neither been audited nor reviewed.

The SQS Group Consolidated Financial Statements for the six month period ended 30 June 2012 were prepared in accordance with uniform accounting and valuation principles in Euros.

Rene GawronChief Financial Officer6 September 2012

Notes to the interim consolidated financial statements (unaudited)

at 30 June 2012

1. Summary of Significant Accounting Policies

Basis of preparation and statement of compliance

The Interim Consolidated Financial Statements of SQS and its subsidiaries ("SQS Group") are prepared in conformity with all IFRS Standards (International Financial Reporting Standards) and Interpretations of the IASB (International Accounting Standards Board) which are mandatory at 30 June 2012, whereas the interim reports are published in an abbreviated form according to IAS 34. The Interim Consolidated Financial Statements have neither been audited nor reviewed.

The accounting policies applied preparing the Interim Consolidated Financial Statements 2012 are consistent with those used for the Consolidated Financial Statements at 31 December 2011.

The Financial Information has been prepared on the historical cost basis. The Financial Information is presented in Euros and amounts are rounded to the nearest thousand (€k) except when otherwise indicated. Negative amounts are presented in parentheses.

The interim consolidated financial statements do not include all the information and disclosures required in the annual financial statements, and should be read in conjunction with the Group's annual financial statements as at 31 December 2011.

Change in accounting policies and correction of errors

At 31 December 2010 pension provisions have been adjusted. This correction has been resulted in the adjustments of Interim Consolidated Financial Statement 2011.

The following table presents the effects of adjustments on the financial statement positions:

There are no effects on the operating result of the Interim Consolidated Financial Statements 2011.

For further information please refer to the Consolidated Financial Statements as of 31 December 2011.

Basis of consolidation

As at 30 June 2012, the Company held interests in the share capital of more than 20 % of the following undertakings (all of those subsidiaries have been consolidated):

SQS AG holds 15% of the shares of SQS Portugal Lda with a book value of € nil (previous year € nil).

Use of estimates

The preparation of the Interim Financial Statements in compliance with the International Financial Reporting Standards requires the disclosure of assumptions and estimates made by management, which have an effect on the amount and the presentation of the assets and liabilities shown in the statement of financial position, the income and expenditure as well as any contingent items. The actual results may deviate from these estimates.

The main estimates and judgements of the management of SQS refer to:

·; the useful life of intangible assets and property, plant and equipment,

·; the criteria regarding IAS 38.57 according the capitalisation of development costs,

·; the recoverability of deferred taxes on losses carried forward,

·; the valuation of pension assets and liabilities.

There have been no changes in estimates compared to the year 2011.

2. Segmental reporting

The SQS Group has two major business units acting as provider for consultancy services in their regions. Both regional business units are operating segments as well as reporting segments and report their financial information to the group management board of SQS AG as chief decision maker. The third reporting unit represents the Training & Conferences business which is reported separately to the management board of SQS AG.

Based on this organisational structure SQS Group reports the following three segments:

·; CEME (Central Europe Middle East),

·; WONS (West Organisation North & South),

·; Other (Training & Conferences).

The segments "WONS" and "CEME" represent the business regions as follows:

·; WONS: UKISA (UK, Ireland and South Africa), SQS Nordic (Sweden, Norway and Finland), SQS India (India, USA)

·; CEME: SQS Germany, SQS Switzerland, SQS Austria, SQS Nederland, SQS Group Management Consulting, SQS Egypt, SQS France.

In the years before the business regarding the selling and leasing of software testing products developed by SQS (STP) has been allocated to the reporting segment "Other". Since January 2012 the internal organisation regarding STP has been changed. As own developed software testing products have become an important part of the managed service business and cannot be separated any more from the testing business STP now is integrated into the operating segments CEME and WONS. The corresponding information regarding the business year 2011 has not been restated because the relevant information is not available and the cost to develop it would be excessive.

The group management board, consisting of CEO (Chief Executive Officer), CFO (Chief Financial Officer) and COO (Chief Operating Officer), monitors the results of the operating segments separately in order to allocate resources and to assess the performance of each segment. Segment performance is evaluated based on operating profit or loss. 

Transactions between the segments are made on an arm's length basis. Centrally incurred external costs relating to subsidiaries are recharged to the subsidiaries affected. Cost allocations between the segments are not charged.

Non-profit centres include important functions such as Portfolio Management, Marketing, Finance & Administration, IT, Human Resources, Managed Services Support and Sales Support.

The non-profit centres are allocated to the operating segments as far as they provide direct services to the segments. As far as they provide general services to the whole group their costs are not allocated and shown under 'Non-allocated costs'.

The assets and liabilities relating to the operating segments are not reported separately to the Group Management Board. Further, finance costs and income taxes are managed on a group basis and are not allocated to operating segments.

The following tables present revenue and profit information regarding the SQS Group's operating segments for the interim period ended 30 June 2012 and 30 June 2011 and for the year ended 31 December 2011, respectively.

If the STP-business had not been integrated in the operating business of CEME and WONS external revenues and segment profit or loss would have been as follows:

3. Expenses

The Consolidated Income Statement presents expenses according to function. Additional information concerning the origin of these expenses, by type of cost, is provided below:

Cost of material

Cost of material included in the cost of sales in the interim period ended 30 June 2012 amounted to €12,778k (at mid-year 2011: €9,331k). Cost of material relates mainly to the procurement of outside services such as contract software engineers. In addition, certain project-related or internally used hardware and software is shown under cost of material.

Employee benefits expenses

The expenses for retirement benefits include the change in pension accruals and expenses for defined contribution plans such as direct insurance and provident fund costs.

Amortisation and depreciation

Amortisation and depreciation charged in the interim period ended 30 June 2012 amounted to €3,533k (at mid-year 2011: €3,371k). Of this, €1,437k (at mid-year 2011: €1,289k) was attributable to the amortisation of development costs.

4. Net finance costs

The net finance costs are comprised as follows:

Finance income results mainly from fixed deposit investments which yield interest income.

Interest expense relates to interest on bank liabilities, finance lease liabilities and bonded loan.

Finance income and costs are stated after foreign exchange rate gains and losses.

5. Taxes on earnings

The line item includes current tax expenses in the amount of €788k (at mid-year 2011: €366k) and deferred tax income in the amount of €239k (at mid-year 2011: €(99)k).

Further information regarding the recognition and measurement of taxes on earnings is provided in the SQS Consolidated Financial Statements at 31 December 2011.

6. Earnings per share

The earnings per share presented in accordance with IAS 33 are shown in the following table:

Undiluted profit per share is calculated by dividing the profit for the six month period attributable to equity shareholders by the weighted average number of shares in issue during the six month period ended 30 June 2012: 27,893,289 (at mid-year 2011: 27,844,245).

Diluted profit per share is determined by dividing the profit for the year attributable to equity shareholders by the weighted average number of shares in issue plus any share equivalents which would lead to a dilution.

The adjusted profit per share is calculated by adjusting the profit after tax for deferred taxes, the amortisation cost of the acquired customer relationships as part of the business combinations, the pension interest expenses and the change in the present value of the corporate income tax asset. This adjusted profit after tax divided by the weighted average number of shares in issue during the six month period ended 30 June 2012: 27,893,289 shares, (at mid-year 2011: 27,844,245 shares) shows adjusted earnings per share of €0.09 (at mid-year 2011: €0.09).

7. Intangible assets

The composition of this item is as follows: